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Grotesque Plan for Detroit: Fleece Working People to Save the Banks

Municipal workers could be robbed of pension funds to pay big banks for payments due on interest rate swaps.

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Holding Main Street Hostage

Detroit’s bankruptcy poses no systemic risk to Wall Street and global financial markets. Fine. But it does pose a systemic risk to Main Street, local governments, and the contractual rights of pensioners. Credit rating agency Moody’s stated in a recent report that if Detroit manages to cut its pension obligations, other struggling cities could follow suit. The Detroit bankruptcy is establishing a template for wiping out government pensions everywhere. Chicago or New York could be next.

There is also the systemic risk posed to the municipal bond system. Bryce Hoffman, writing in The Detroit News on July 30th, warned:

Detroit’s bankruptcy threatens to change the rules of the municipal bond game and already is making it more expensive for the state’s other struggling towns and school districts to borrow money and fund big infrastructure projects.

In fact, one bond analyst told The Detroit News that he has spoken to major institutional investors who have already decided to stop, for now, buying any Michigan bonds.

The real concern of bond investors, says Hoffman, is not the default of Detroit but the precedent the city is setting. General obligation municipal bonds have always been viewed as a virtually risk-free investment. They are unsecured, but bondholders have considered themselves protected because the bonds are backed by the “unlimited taxing authority” of the government that issued them. Detroit, however, has shown that the city’s taxing authority is far from unlimited.  It already has the highest property taxes of any major city in the country, and it is bumping up against a ceiling imposed by the state constitution. If Detroit is able to cut its bond debt in half or more by defaulting, other distressed cities are liable to look very closely at following suit. Hoffman writes:

The bond market is warning that this will make Michigan a pariah state and raise borrowing costs — not just for Detroit and other troubled municipalities, but also for paragons of fiscal virtue such as Oakland and Livingston counties.

However, writes Hoffman:

Gov. Rick Snyder dismisses that threat and says the bond market is just trying to turn Detroit away from a radical solution that could become a model for other struggling cities across America.

A Safer, Saner, More Equitable Model

Interestingly, Lansing Mayor Virg Bernero, Snyder’s Democratic opponent in the last gubernatorial race, proposed a solution that could have avoided either robbing the pensioners or scaring off the bondholders: a state-owned bank. If the state or the city had its own bank, it would not need to borrow from Wall Street, worry about interest rate swaps, or be beholden to the bond vigilantes. It could borrow from its own bank, which would leverage the local government’s capital into credit, back that credit with the deposits created by the government’s own revenues, and return the interest to the government as a dividend, following the ground-breaking model of the state-owned Bank of North Dakota.

There are other steps that need to be taken, and soon, to prevent a cascade of municipal bankruptcies.  The super-priority of derivatives in bankruptcy needs to be repealed, and the protections of Glass Steagall need to be restored. While we are waiting on a very dilatory Congress, however, state and local governments might consider protecting themselves and their revenues by setting up their own banks.

Ellen Brown is an attorney, chairman of the Public Banking Institute, and author of twelve books including the bestselling Web of Debt. In her latest book, The Public Bank Solution, she explores successful public banking models historically and globally. She is currently running for California State Treasurer on a state bank platform.